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Chapter 23: Q20Q (page 1372)

Question: What are some of the arguments in favor of using the indirect (reconciliation) method as opposed to the direct method for reporting a statement of cash flows?

Short Answer

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Answer

The indirect method is preferred over the direct method of cash flow because it does not require additional efforts for preparation; it is according to the accrual basis of accounting and also defines the difference between the net income and cash from operations.

Step by step solution

01

Definition of Cash Flow Statement

The statement prepared by the business entity providing the information regarding all the transactions that increase or decrease the cash balance is known as the cash flow statement. Such a statement is prepared in three sections.

02

Arguments in favor of using the indirect method

  1. The indirect method highlights the difference between the net income of the business entity and the cash generated from the operations.
  2. The direct method statement of cash flow confuses the financial statement's users with knowledge of only the accrual basis of accounting.
  3. Direct method cannot be justified based on cost-benefit analysis because it will require additional efforts as all other statements are prepared based on accrual accounting.

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Most popular questions from this chapter

Data for Krauss Company are presented in E23-5.

Instructions

Prepare the operating activities section of the statement of cash flows using the indirect method.

What are the major sources of cash (inflows) in a statement of cash flows? What are the major uses (outflows) of cash?

Identify and explain the major steps involved in preparing the statement of cash flows.

Under IFRS, significant non-cash transactions:

  1. are classified as operating, if they are related to income items.
  2. are excluded from the statement of cash flows and disclosed in a narrative form or summarized in a separate schedule.
  3. are classified as an investing or financing activity.
  4. are classified as an operating activity, unless they can be specifically identified with financing or investing activities.

Each of the following items must be considered in preparing a statement of cash flows (indirect method) for Turbulent Indigo Inc. for the year ended December 31, 2017.

(a) Plant assets that had cost \(20,000 6 years before and were being depreciated on a straight-line basis over 10 years with no estimated scrap value were sold for \)5,300.

(b) During the year, 10,000 shares of common stock with a stated value of \(10 a share were issued for \)43 a share.

(c) Uncollectible accounts receivable in the amount of \(27,000 were written off against Allowance for Doubtful Accounts.

(d) The company sustained a net loss for the year of \)50,000. Depreciation amounted to \(22,000, and a gain of \)9,000 was realized on the sale of land for \(39,000 cash.

(e) A 3-month U.S. Treasury bill was purchased for \)100,000. The company uses a cash and cash equivalent basis for its cash flow statement.

(f) Patent amortization for the year was \(20,000.

(g) The company exchanged common stock for a 70% interest in Tabasco Co. for \)900,000.

(h) During the year, treasury stock costing $47,000 was purchased.

Instructions State where each item is to be shown in the statement of cash flows, if at all.
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